A 26-year old Bitcoin entrepreneur was handed prison time, and the experience only confirmed his belief in the cryptocurrency

Markets Insider

Dec. 4, 2016, 09:04 AM

The rise of 26-year old Charlie Shrem was swift. So was his fall.

The self-professed computer geek turned divisive digital currency entrepreneur won notoriety as the founder of BitInstant. The firm took off, attracting investors like the Winklevoss twins, and helping popularize bitcoin.

Then, his whole world came crashing down. He was charged with operating an unlicensed money transmitting business. He pled guilty, and was given prison time.

Shrem got of prison earlier this year, and his experience there hasn't deterred his faith in bitcoin and blockchain, the technology behind it. In fact, an incident with a prison guard and mackerels, the currency of choice in prison, only confirmed his belief in an alternative currency system.

A computer geek

Shrem opened up about his prison experience and his past on Wall and Broadcast, a podcast hosted byTABB Group COO Alex Tabb, TABBForum producer Anna Stumpf andVested CEO Dan Simon.

Raised in a deeply religious orthodox Jewish household, Shrem describes himself as an "outcast" at Yeshiva high school. "I just loved computers," he said in the podcast. "I would hang out in the internet chat rooms and all of the places where all socially awkward people hang out."

Shrem first heard about the concept of Bitcoin from a friend in an internet forum he was a part of. "There was no website or anything," he said in the podcast. "Only a white paper," referring to the research paper released under the pseudonym Satoshi Nakimoto that unveiled the concept.

Bitcoin is a digital currency in which transactions occur peer-to-peer, meaning no government or third party is involved. Shrem was immediately interested and purchased a few thousand bitcoin - at the time worth very little.

He caught the entrepreneurial bug early, founding Daily Checkout, a daily deal website that sold refurbished used goods, at 18. He also attended night school at Brooklyn College and got introduced to the Austrian School of Economics, an economic theory that promotes laissez-faire ideals and the elimination of government intervention.

In his mind, something clicked. "I realized that bitcoin was taking all of that Austrian economic theory and putting it into practice," he said in the podcast.

It was on Bitcointalk.org that he got the idea for a way to make the purchasing of bitcoin faster and more accessible to the every day consumer. He launched BitInstant, which partnered with payment processors that had physical locations at CVS, Duane Reade, Walmart, Walgreens and 7-11, among others. The site allowed people to buy small amounts of bitcoin (with an average ticket size of $300-500) and charged customers a small fee for each transaction.

"Within a few months, we enabled people to be able to buy bitcoin at almost a million locations in the US," Shrem said in the podcast. "And overnight volume exploded."

The company achieved an average growth rate of 1.5x per month, according to Shrem, with advertising limited to word of mouth. At one point, the company was facilitating transactions worth a million dollars a day, he said.

The growth of BitInstant attracted investors like the Winklevoss twins and angel investor Roger Vere. They moved into bigger offices, shrouded in secrecy. "We needed an army security guard, our own floor, and shaded windows," he said.

Soon the two man band become a 30 person office, and he admits in the podcast interview that he let the success get to his head.

"I started drinking too much," he said. "I invested in my friend's nightclub. In fact, I lived upstairs in the nightclub."

The fall of BitInstant was just as quick as its rise.

The fall of BitInstant

In March 2013, regulators enforced a ruling that outlined what type of companies were now considered money transmitters.

Suddenly, BitInstant was operating without a license. "We couldn't take the risk of operating illegally," Shrem said in the podcast, "so we shut down...It was heartbreaking."

Eight months later, Shrem travelled to Amsterdam to speak at a conference. It was when he returned to JFK airport that he was confronted by a dozen law enforcement officials, a joint task force of the FBI, IRS, DEA and other officials, he said in the podcast.

Shrem had knowingly facilitated transactions to a re-seller, Robert Faiella, whose customers were using the Silk Road, an underground bitcoin only marketplace where people buy and sell illegal drugs. The re-seller was also trying to deposit more money than the new money transmitter laws allowed for, and these transactions were done behind the scenes to get around reporting requirements.

On September 4 2014, Faiella and Shrem both pled guilty in connection with the sale of approximately $1 million in bitcoins for use on the Silk Road website.

"Robert Faiella and Charlie Shrem opted to travel down a crooked path - running an illegal money transmitting business that catered to criminals bent on trafficking narcotics on the dark web drug site, Silk Road," Prett Bharara,United States Attorney for the Southern District of New York, said in a statement at the time.

Shrem, who was also Chief Compliance Officer of BitInstant and thus in charge of compliance with federal anti-money laundering (AML) laws, was fully aware that Silk Road was a drug-trafficking website and that he was operating a Bitcoin exchange service for Silk Road users.

Nevertheless, he "knowingly facilitated Faiella’s business with the company in order to maintain Faiella's business as a lucrative source of revenue, " according to the court report.

"Even though it was Shrem’s job to enforce the Company’s AML restrictions...[he] failed to file a single suspicious activity report with the US Treasury Department about Faiella's illicit activity...and deliberately helped Failla circumvent the Company’s AML restrictions."

Shrem knew what he was doing, he said in the podcast, and he admits his guilt.

Digitizing the Prison Economy

Prison "was no country club, but it wasn't Rikers Island either," he explained in the podcast.

One out of every ten prisoners were white collar criminals - a state senator, a judge, and a few law enforcement officials were among his group. They were all nonviolent offenders so the fear wasn't as great as in maximum security persons.

That's not to say it was easy settling in.

"Everything here is word of mouth," he said in the podcast. "There is no Google, information is trickling in. I think the hardest part is learning to use my own resources to grow, and not the internet."

On the outside, he had this Bitcoin celebrity status, he said, and in the prison, nobody knew him nor did they care about him. "I needed to humble myself."

Of particular fascination to Shrem was the prison currency system, which involved bartering mackerels. According to an article in the Wall Street Journal, there has been a mackerel economy in federal prisons since about 2004, when federal prisons prohibited smoking and, by default, the cigarette pack, which was the earlier gold standard. Prisoners need a proxy for the dollar because they're not allowed to possess cash.

Every inmate can only buy 14 mackerels per week, said Shrem, so there is a certain number in circulation in the prison. Also, not all mackerels are created equal. The fish expire after about 3 years, after which their value depreciates. Expired mackerels, referred to as "money macks," retain 75% of the value of the "eating macks," or non-expired fish, explained Shrem. There were currency exchanges between the two, and everything had two prices in the prison.

One day, a large number of mackerels were confiscated by prison guards and left out for any prisoner to take. Overnight, the guards essentially introduced hyperinflation, said Shrem, and flooded the market. They lost all of their value.

This got Shrem thinking. He started to think about the value of digitizing the prison economy and putting it on the blockchain.

If there was a shared, distributed ledger among say a dozen inmates, everyone would have a real-time record of all transactions that occurred in the prison. All members would have to verify and validate a transaction to make sure it was legitimate before taking place.

"Everyone has a financial incentive to make sure the system maintains its integrity," said Shrem.

The experience reminded him of how blockchain could not only be useful, but also necessary - not only in the financial services world, but in the prison world. "It avoids the guards having power over the value of the mackerel.

Shrem's belief in the power of the bitcoin blockchain and the elimination of the middleman continues. He sees the digital currency as a "great equalizer" and believes that bitcoin will do to money what email did to the postal service. "It will allow everyone to be equal."

Digital currencies have also been challenged by recent security issues. In August, hackers stole $72 million worth of bitcoin from accounts at the Hong Kong cryptocurrency exchange Bitfinex. And in June, hackers stole $55 million worth of ether, a bitcoin rival. The nonprofit that runs ether, Ethereum Foundation, just rolled back the chain. It's as if the hack never took place, and business returned to normal. But that worries purists like Shrem.

He continues to be a staunch believer in the integrity of the blockchain and denounces Ethererum's decision to roll back the chain, even though he said he is friends with the founder. "Once you change the ledger for one specific reason, then you've already set the precedent."

"I used to be a bitcoin maximalist, thinking bitcoin is the one and only blockchain," he said to Wall & Broadcast. "Now I believe that alternate chains can and do exist."